Glossary

Discount Rate Derivation (Build-Up Method)

Also known as: Build-Up Method

A technique for constructing a property-specific discount rate by starting from a safe-rate benchmark, typically a long-term Treasury yield, and adding a series of risk premiums — for illiquidity, management burden, and property-specific risk — to arrive at the rate used to discount projected cash flows in a DCF analysis.

The build-up method's components typically include the risk-free rate, an illiquidity premium compensating for real estate's comparatively long marketing and closing timelines relative to securities, a management/burden premium compensating for the active asset management real estate requires relative to a passive investment, and a property-specific risk premium reflecting factors such as tenant credit, lease rollover exposure, location, and physical condition; each component is a matter of appraiser judgment rather than a directly observable market input, which is the method's principal weakness relative to market-extracted rates. Because build-up components are additive and individually somewhat subjective, the method is most defensible when cross-checked against, rather than substituted for, discount rates extracted from actual transactions via market extraction or from investor surveys published by national research firms tracking institutional return expectations by property type and market tier. In practice, appraisers frequently reconcile a build-up estimate against survey-derived and market-extracted rates and select a final discount rate that falls within the range those independent methods support, documenting the reconciliation rather than relying on any single derivation method alone.